Beware The Negative Impacts of Carbon Taxation
Carbon taxation is commonly championed by environmentalists. In a recently published op-ed on CNA, Professor Angel Hsu urged the Singapore government to ramp up carbon taxation.
When I look at the manifesto of the Green Dot climate activists this past September, I see the same proposals for carbon taxes being echoed.
What I find striking about many of these carbon tax proposals in Singapore is that they are framed in a way to give the impression that carbon tax policies would be all wins and zero losses.
This is easy to infer from the fact that advocates of the carbon tax do not make even the slightest reference to the long list of negative economic costs and/or impact that carbon tax policies might entail on an economy.
This is very obviously a highly misleading and false picture. Carbon tax policy involves numerous different trade-offs and difficulties that economists and policymakers have to grapple with when implemented in real world economies. A wealth of scholarly evidence has demonstrated these problems.
A regressive tax
Carbon taxes are commonly understood to be a regressive tax – it disproportionately hurts the poor more than the rich, since the less well-off spend a larger proportion of their income on energy consumption.
In a recent video, popular internet personality Xiaxue highlights the same point (at around the 8:30 mark) on the regressive nature of carbon taxes.
Consider Australia’s 2012 experiment with carbon taxation. Did it achieve a reduction in CO2 emissions? The answer is unquestionably yes. But that wasn’t achieved without costs.
Within the first year, consumers were hit hard when household electricity prices rose 15 percent with record quarterly rate jumps. Unsurprisingly, there were direct links between the tax and business closures in manufacturing sectors. Unemployment figures climbed by at least 70,000 over the period of a year according to official Australian government statistics.
The tax was considered such a disaster to the economy that it was repealed a mere two years later. Official statistics from the Australian Treasury estimated that the average household would save an average of 550AUD (514SGD) per year after the repeal of the regressive tax.
In their enthusiasm to reduce carbon emissions, many overlook that it is only the middle and upper-income families that can withstand these price increments, while the low-income worker who is living from pay cheque to cheque that will bear a larger tax burden on his cost of living.
The concept of revenue neutrality
To be sure, economists have acknowledged the regressive nature of carbon taxes and proposed measures to remedy for it. For example, the Singapore government is doing just that in the form of the GST Voucher U-Save rebates. The idea is that the government will offset any tax burdens on the poor and any harm to economic growth by giving money back to citizens or through the lowering of other taxes in order to achieve “revenue neutrality”.
The only problem is that government promises of revenue neutrality has been anything but “neutral”.
In 2008, the government of British Columbia implemented a carbon tax on the unprecedented political campaign of “revenue neutrality”. This was a big deal for local Canadian voters and businesses due to the competition it faces from nearby North American jurisdictions.
But not long after the carbon tax went into effect, the revenue neutrality commitment was quickly forgotten and abandoned for various political reasons, hanging the lower and middle classes up to dry. The British Columbian government’s tax revenues soared as the tax started at 10 CAD in 2008, rose to 30 CAD in 2012 and is projected to reach 50 CAD by 2021.
Unfortunately, revenue neutrality almost never plays out as elegantly within the confines of a theoretical model on a chalkboard. In the realm of political reality, governments almost always are able to find more reasons to spend – negating its initial promise of revenue neutrality.
The tax interaction effect
The second problem with revenue neutrality is a little-known concept called the tax interaction effect, pioneered by Stanford economist Lawrence Goulder as early as 1996. Goulder shattered the simplistic idea that that governments can compensate workers from the economic damage of a carbon tax through simple rebate scheme or tax reductions.
Why? Simply because the impact of carbon taxes are not equal to other types of taxes. Carbon taxes are targeted at a much narrower tax base (energy producers) in comparison to broad-based taxes like labour and consumption. Therefore, carbon taxes have a bigger distortionary effect in how the economy operates.
When only energy producers are slapped with a tax, the increase in energy prices will first penalise high energy consumption activities. In Singapore, this would hit the bulk of our economy since 2018 EMA statistics show that 79% of total electricity consumption come from industrial and commerce-related activities, while households make only 14.7%.
This then trickles down to local businesses whom will inevitably react in other cost-cutting measures. The overall effect is the retardation of wealth creation and economic productivity, subsequently manifesting in lower take-home earnings – or even worse, unemployment – for workers.
Economists who study the tax interaction effect find that the impact that carbon taxes have on wealth creation are far more destructive to a worker’s earnings than the amount that is compensated in tax rebates. Supporters of revenue neutrality believe it possible to reduce a dollar in other taxes for every other dollar raises in carbon taxes, when in fact economic realities are far more complex than that.
Brief remarks on policy solutions
Environmental activists need to be fully cognisant of the detrimental economic impacts from taxing carbon. More importantly, they need to be honest with the public about it.
Activists might rebut by saying that the economic costs were a worthy trade-off for the CO2 reductions.
Firstly, this is not a statement that can be easily qualified. To say that the reduction of economic growth in the present is a worthwhile trade-off against the costs of climate change in 20 years in the future is a value statement loaded with many underlying assumptions such as the discount rate and time horizon. Academic scholars have been arguing about the reliability of these assumptions for years, with no clear consensus.
Second, if that was so, then why are local environmentalists silent on the economic costs? Why are these very real short-term costs omitted in their public speeches, articles and manifestos?
It is exceedingly easy for environmental activists to point an accusatory finger at the power plants in Jurong and demand the reduction of emissions. But it’s much harder to face the economic reality of how lower-income Singaporeans will suffer the brunt of the rise in electricity costs, and how Singaporeans will be potentially put at risk of unemployment (especially those employed in the energy-intensive sectors).
Singapore’s situation is especially unique given its high trade export dependency and small geographic size. This entails large economic costs with carbon tax policies and a limited scope for renewables like wind and solar. We should not be basing our carbon tax policies on international “averages” that are handed down by intergovernmental bodies.
What is sorely needed are solutions that are economically sensible such as nuclear energy. To date, the use of nuclear energy has saved more than 1.8 billion lives by preventing the burning of fossil fuels. Testament to its efficacy, even the UN IPCC in 2014 acknowledged that alternative energy being considered must also include nuclear. For a land-scarce country like Singapore, nuclear makes perfect sense, since it needs about 400 times less land than solar and wind, but at the same time producing 4 times less carbon than solar farms.
Ironically, climate activists have long opposed it due to accidents like Chernobyl and Fukushima. Yet, nuclear energy has been proven to be one of the safest forms of energy. The availability of nuclear technology, coupled with the right human capital, should give policymakers the confidence to think boldly about using it.
Another bold and innovative technology to be considered is geo-engineering, which involves the release of particles, mainly sulphur dioxide into the atmosphere to manipulate global temperatures. Some expect that this approach can mitigate global temperatures by up to several degrees in the next few decades. The genius of this lies in the fact it is proven to work – as past volcanic eruptions have shown – and is very affordable. Improving on this technology also translates into training a whole new generation of scientists and engineers, an economic boon to any nation.
More generally, aside from big investments into specific policies, we must also embrace a wider, decentralised approach to carbon mitigation. Climate change is a multi-faceted problem and requires the participation of many stakeholders for it to be adequately addressed.
Governments can pursue market-based policies such as the offer of tax cuts and/or grants to incentivise and spur bottom-up “enviropreneurship”. This better empowers market entrepreneurs and green civil society groups on the ground who are better equipped to pursue various conservationist and environmentally sustainable solutions.
On this note, an important factor to consider is the accumulation of human capital in urban cities. More must be done to attract, and develop talents within city-areas, which are typically the focal point of new emerging ideas. The climate economist Matthew Kahn from John Hopkins has shown how urbanisation, particularly, cities that are open to talent and migration, are most promising for developing new environmental technologies. As the late great economist Julian Simon taught us: More people, more minds, better solutions.